Alliance Fiber Optic Products 10Q 2013 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________________

FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number 0-31857

ALLIANCE FIBER OPTIC PRODUCTS, INC.
(Exact name of registrant as specified in its charter)

Delaware		77-0554122
(State or other jurisdiction of		(I.R.S. employer
Incorporation or organization)		identification number)

275 Gibraltar Drive, Sunnyvale, California 94089
(Address of Principal Executive Offices)

(408) 736-6900
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YesþNo¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YesþNo¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	Accelerated Filer	Non-accelerated filer	Smaller reporting companyþ
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨Noþ

On October 31, 2013, 18,335,022 shares of the registrant’s Common Stock, $0.001 par value per share, were outstanding.

ALLIANCE FIBER OPTIC PRODUCTS, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED SEPTEMBER 30, 2013

INDEX

		Page
PART I: FINANCIAL INFORMATION		1
	ITEM 1: FINANCIAL STATEMENTS	1
	Condensed Consolidated Balance Sheets	1
	Condensed Consolidated Statements of Income and Comprehensive Income	2
	Condensed Consolidated Statements of Cash Flows	3
	Notes To Condensed Consolidated Financial Statements	4
	ITEM 2:MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
	RESULTS OF OPERATIONS	12
	ITEM 3:QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	17
	ITEM 4:CONTROLS AND PROCEDURES	17
PART II: OTHER INFORMATION		18
	ITEM 1A: RISK FACTORS	18
	ITEM 5. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	27
	ITEM 6: EXHIBITS	28
SIGNATURES		29

PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

ALLIANCE FIBER OPTIC PRODUCTS, INC.
Condensed Consolidated Balance Sheets

(In thousands, except share data)

	September 30,			December 31,
	2013			2012
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	15,237		$	4,793
Short-term investments		30,437			28,482
Accounts receivable, net		12,365			8,046
Inventories, net		10,236			6,933
Deferred tax asset		1,234			1,234
Prepaid expense and other current assets		2,122			1,166
Total current assets		71,631			50,654

Long-term investments		10,408			10,274
Property and equipment, net		10,292			7,708
Deferred tax asset		2,468			2,468
Other assets		197			249
Total assets	$	94,996		$	71,353

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	12,242		$	6,591
Accrued expenses		6,038			4,115
Total current liabilities		18,280			10,706

Other long-term liabilities		604			616
Total liabilities		18,884			11,322

Commitments and contingencies (Note 9)

Stockholders' equity:
Preferred stock, par value $0.001: 5,000,000 shares authorized:
no shares issued and outstanding at September 30, 2013 and
December 31, 2012, respectively		-			-
Common stock, $0.001 par value: 20,000,000 shares authorized;
18,331,022 and 17,264,926 shares issued and outstanding at
September 30, 2013 and December 31, 2012.		18			9
Additional paid-in-capital		116,313			111,900
Accumulated deficit		(42,919	)		(54,672	)
Accumulated other comprehensive income		2,700			2,794
Stockholders' equity		76,112			60,031
Total liabilities and stockholders' equity	$	94,996		$	71,353

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements

Share and per share amounts reflect a 2-for-1 stock split of the outstanding common stock effected on August 30, 2013.

ALLIANCE FIBER OPTIC PRODUCTS, INC.
Condensed Consolidated Statements of Income and Comprehensive Income

(Unaudited, in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenues	$	23,074		$	12,390		$	54,266		$	34,452
Cost of revenues		14,218			7,979			33,722			22,688
Gross profit		8,856			4,411			20,544			11,764
Operating expenses:
Research and development		1,024			819			2,696			2,465
Sales and marketing		835			614			2,338			1,951
General and administrative		1,339			1,079			3,640			3,281
Total operating expenses		3,198			2,512			8,674			7,697
Income from operations		5,658			1,899			11,870			4,067
Interest and other income, net		173			194			469			504
Net income before income tax		5,831			2,093			12,339			4,571
Income tax		(210	)		(201	)		(586	)		(526	)
Net income	$	5,621		$	1,892		$	11,753		$	4,045

Cumulative translation adjustments		183			303			(97	)		585
Unrealized gain on investments		3			42			2			33
Comprehensive income	$	5,807		$	2,237		$	11,658		$	4,663

Net income per share:
Basic	$	0.31		$	0.11		$	0.67		$	0.23
Diluted	$	0.30		$	0.11		$	0.65		$	0.22
Shares used in computing net income per share:
Basic		18,056			17,581			17,584			17,638
Diluted		18,754			17,977			18,107			18,000

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

Share and per share amounts reflect a 2-for-1 stock split of the outstanding common stock effected on August 30, 2013.

ALLIANCE FIBER OPTIC PRODUCTS, INC.
Condensed Consolidated Statements of Cash Flows

(Unaudited, in thousands)

	Nine Months Ended September 30,
	2013			2012
Cash flows from operating activities:
Net Income	$	11,753		$	4,045
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization		1,513			1,189
(Gain) Loss on disposal of property and equipment		(5	)		6
Amortization of stock-based compensation		1,254			786
Deferred restricted stock unit compensation		(1,326	)		(647	)
Provision for inventory		(222	)		164
Changes in assets and liabilities:
Accounts receivable		(4,318	)		(1,662	)
Inventories		(3,081	)		(703	)
Prepaid expenses and other assets		(956	)		(1,056	)
Other assets		53			(52	)
Accounts payable		5,651			2,592
Accrued expenses		1,923			649
Other long-term liabilities		(12	)		34
Net cash provided by operating activities		12,227			5,345

Cash flows from investing activities:
Purchase of short-term investments		(16,028	)		(17,193	)
Proceeds from sales and maturities of short-term investments		14,075			8,850
Purchase of long-term investments		(134	)		(131	)
Purchase of property and equipment		(4,025	)		(717	)
Net cash used in investing activities		(6,112	)		(9,191	)

Cash flows from financing activities:
Proceeds from issuance of common stock under ESPP		235			207
Proceeds from the exercise of stock options		5,131			477
Repurchase of common stock		(873	)		(2,395	)
Repayments of bank borrowings		-			(230	)
Net cash provided by (used in) financing activities		4,493			(1,941	)

Effect of exchange rate changes on cash and cash equivalents		(164	)		485
Net increase (decrease) in cash and cash equivalents		10,444			(5,302	)
Cash and cash equivalents at beginning of period		4,793			13,820
Cash and cash equivalents at end of period	$	15,237		$	8,518

Supplemental disclosure of cash flow information:
Cash paid for interest	$	-		$	(4	)
Cash paid for income tax	$	(340	)	$	(379	)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

ALLIANCE FIBER OPTIC PRODUCTS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Summary of Significant Accounting Policies

The Company

Alliance Fiber Optic Products, Inc. (the “Company”) was incorporated in California on December 12, 1995 and reincorporated in Delaware on October 19, 2000. The Company designs, manufactures and markets fiber optic components for communications equipment manufacturers and service providers. The Company’s headquarters are located in Sunnyvale, California, and it has operations in Taiwan and China.

Basis of Presentation

The accompanying condensed consolidated balance sheet as of December 31, 2012, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements as of September 30, 2013 and for the three and nine months ended September 30, 2013 and 2012 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and include the accounts of Alliance Fiber Optic Products, Inc. and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations.

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The unaudited condensed consolidated financial statements as of September 30, 2013, and for the three and nine months ended September 30, 2013 and 2012, reflect, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial information set forth herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for any subsequent interim period or for an entire year.

There have been no significant changes in the Company’s critical accounting policies during the nine months ended September 30, 2013 as compared to what was previously disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2012.

Revenue Recognition

The Company recognizes revenue upon shipment of its products to customers, provided that it has received a purchase order, the price is fixed, collection of the resulting receivable is reasonably assured and transfer of title and risk of loss has occurred. Subsequent to the sale of products, the Company has no obligation to provide any modification or customization upgrades, enhancements or post contract customer support.

Allowance for Doubtful Accounts

Allowances are provided for estimated returns and potential uncollectable trade receivables. Provisions for return allowances are recorded at the time revenue is recognized based on historical returns, current economic trends and changes in customer demand. Such allowances are adjusted periodically to reflect actual and anticipated experience. The Company also identifies specific accounts considered to have a high risk of uncollectibility and reserves the full amount. Material differences may result in the amount and timing of revenue for any period than if management had made different judgments or utilized different estimates.

Cash and Cash Equivalents

The Company considers all highly liquid instruments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents consist primarily of market rate accounts, corporate bonds and certificates of deposit.

Short-Term and Long-Term Investments

The Company generally invests its excess cash in certificates of deposit, corporate bonds, and commercial paper. Such investments are made in accordance with the Company’s investment policy, which establishes guidelines relative to diversification and maturities designed to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates.

Concentrations of Risk

Connectivity products contributed 76.2% and 67.0% of the Company’s revenues for the three months ended September 30, 2013 and 2012, respectively. The Company’s optical passive products contributed 23.8% and 33.0% of the Company’s revenues for the three months ended September 30, 2013 and 2012, respectively.

Connectivity products contributed 75.5% and 71.4% of the Company’s revenues for the nine months ended September 30, 2013 and 2012, respectively. The Company’s optical passive products contributed 24.5% and 28.6% of the Company’s revenues for the nine months ended September 30, 2013 and 2012, respectively.

In the three months ended September 30, 2013 and 2012, the Company’s 10 largest customers comprised 79.1% and 66.3% of the Company’s revenues, respectively. For the three months ended September 30, 2013, two customers accounted for 40.1% and 11.2% of the Company’s total revenues, respectively. Amounts due from these customers were $4.5 million and $1.4 million, respectively, at September 30, 2013. For the three months ended September 30, 2012, three customers accounted for 14.1%, 11.0% and 10.1% of the Company’s total revenues, respectively. Amounts due from these customers were $1.5 million, $1.0 million and $0.8 million, respectively, at September 30, 2012.

In the nine months ended September 30, 2013 and 2012, the Company’s 10 largest customers comprised 74.5% and 62.9% of the Company’s revenues, respectively. For the nine months ended September 30, 2013, two customers accounted for 32.4% and 10.4% of the Company’s total revenues. For the nine months ended September 30, 2012, no customer accounted for 10% or more of the Company’s revenues.

2. Recent Accounting Pronouncements and Accounting Changes

In July 2013, the Financial Accounting Standards Board (“FASB”) issued guidance on the presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss or tax carryforward exists. The FASB concluded that an unrecognized tax benefit should be presented as a reduction of a deferred tax asset except in certain circumstances the unrecognized tax benefit should be presented as a liability and should not be combined with deferred tax assets. The amendment is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted. The Company is currently evaluating the impact this amendment may have on its consolidated financial statements.

In March 2013, the FASB issued guidance to clarify when to release cumulative foreign currency translation adjustments when an entity ceases to have a controlling financial interest in a subsidiary or group of assets within a foreign entity. The amendment is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013 and should be applied prospectively to derecognition events occurring after the effective date. Early adoption is permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

In February 2013, the FASB issued guidance requiring presentation of amounts reclassified from each component of accumulated other comprehensive income. In addition, disclosure is required of the effects of significant reclassifications on income statement line items either on the face of the statement where net income is presented or as a separate disclosure in the notes to the financial statements. For public entities, this guidance is effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

3. Stockholders’ Equity

On August 15, 2013, the Company announced it had declared a 2-for-1 stock split of the Common Stock of the Company (“Common Stock”), for distribution on September 16, 2013 to stockholders of record holding shares of Common Stock at the close of business on August 30, 2013. All share and per share amounts in the accompanying financial statements have been retroactively restated to reflect such stock split.

4. Stock-based Compensation

The Accounting Standards Codification (“ASC”) 718 requires companies to record compensation expense for stock options measured at fair value, on the date of grant, using an option-pricing model. The fair value of stock options granted and stock purchased pursuant to the Employee Stock Purchase Plan (“ESPP”) prior to June 30, 2010 was determined using the Binomial Lattice Model.

Pursuant to the Company’s 2000 Stock Incentive Plan, participants may be granted restricted stock units (“RSUs”), representing an unfunded, unsecured right to receive a Company common share on the date specified in the recipient’s award. The RSUs granted under the plan generally vest over two years at a rate of 50 percent per year or over five years at a rate of 20 percent per year. The Company recognizes compensation expense on a straight-line basis over the vesting term of each award.

Options granted under the 2000 Stock Incentive Plan generally vest over four years. Options are exercisable for not more than ten years.

The following information relates to stock option activity for the nine months ended September 30, 2013:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
Options	Shares		Price		Life	Value
Outstanding at December 31, 2012	1,436,360		$	3.92
Granted	212,800			7.12
Exercised	(1,046,560	)		3.87
Forfeited	-			-
Outstanding at September 30, 2013	602,600		$	5.14	7.86 Years	$	9,240,663
Vested and expected to vest at September 30, 2013	602,600		$	5.14	7.86 Years	$	9,240,663
Exercisable at September 30, 2013	148,360		$	3.74	4.25 Years	$	2,481,962

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of fiscal 2013 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2013. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercised was $9.5 million and $12.3 million for the three and nine months ended September 30, 2013,respectively. The total intrinsic value of options exercised was $0.08 million and $0.5 million for the three and nine months ended September 30, 2012, respectively.

No options were granted during the three months ended September 30, 2013 or 2012. As of September 30, 2013, there was $3.6 million of unrecognized compensation cost related to share-based compensation arrangements granted under the Plan. The compensation cost is expected to be realized over four years.

Cash received from option exercises during the three and nine months ended September 30, 2013 was $2.4 million and $3.8 million, respectively, and is included within the financing activities section in the accompanying condensed consolidated statements of cash flows.

During the nine months ended September 30, 2013, a total of 51,232 shares were issued under the Company’s ESPP and cash received from purchases of common stock was $0.2 million. Compensation expense recorded in the quarter ended September 30, 2013 related to the ESPP was approximately $0.09 million. As of September 30, 2013, there was $0.03 million of unrecognized compensation cost related to the ESPP which is expected to be realized over the next month.

During the nine months ended September 30, 2011, the Company granted 546,000 RSUs with a total grant-date fair value of $2.5 million. The resulting compensation expense recorded in the quarter ended September 30, 2013 was $0.1 million. There was $1.0 million of total unrecognized compensation cost related to RSUs granted under the Plan, all of which is expected to be realized over three years.

During the nine months ended September 30, 2013, the Company granted 342,000 RSUs with a total grant-date fair value of $2.3 million. The resulting compensation expense recorded in the quarter ended September 30, 2013 was $0.3 million. There was $1.9 million of total unrecognized compensation cost related to RSUs granted under the Plan, of which $1.0 million is expected to be realized over two years and $0.9 million is expected to be realized over three years.

The following table summarizes employee stock-based compensation expense resulting from stock options, RSUs, and the ESPP (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Included in cost of revenue	$	116	$	28	$	215	$	86
Included in operating expenses:
Research and development		71		32		149		92
Sales and marketing		132		65		295		188
General and administrative		244		143		595		420
Total		447		240		1,039		700
Total stock-based compensation expense	$	563	$	268	$	1,254	$	786

5. Inventories, net (in thousands)

	September 30,		December 31,
	2013		2012
Inventories:
Finished goods	$	2,635	$	1,824
Work-in-process		4,019		2,546
Raw materials		3,582		2,563
	$	10,236	$	6,933

6. Net Income Per Share

Basic net income per share is computed by dividing net income for the period by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing net income for the period by the combination of dilutive common share equivalents, comprised of shares issuable under the Company’s stock-based compensation plans, and the weighted-average number of shares of common stock outstanding during the period. There were no incremental dilutive common share equivalents in the periods presented.

The following table sets forth the computation of basic and diluted net income per share for the periods indicated (in thousands, except per share data):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Numerator:
Net income	$	5,621	$	1,892	$	11,753	$	4,045
Denominator:
Shares used in computing net income per share:
Basic		18,056		17,581		17,584		17,638
Diluted		18,754		17,977		18,107		18,000
Net income per share:
Basic	$	0.31	$	0.11	$	0.67	$	0.23
Diluted	$	0.30	$	0.11	$	0.65	$	0.22

7. Comprehensive Income

Comprehensive income is defined as the change in equity of a company during a period resulting from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. The difference between net income and comprehensive income for the Company is due to foreign exchange translations adjustments and unrealized gain on available-for-sale securities.

8. Income Taxes

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

The Company’s effective tax rate was below the U.S. statutory rate primarily because of the tax benefit arising from net operating loss carryforwards. The Company is subject to income tax in both the United States and various foreign jurisdictions. The effective tax rate is also affected by the taxable earnings in foreign jurisdictions with various different statutory tax rates. The Company reviews its expected annual effective income tax rates and makes changes on a quarterly basis as necessary based on certain factors such as forecasted annual operating income and valuation of deferred tax assets.

The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. In making such determination, management considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event the Company was to determine that it would be able to realize its deferred income tax assets in the future in excess of their net recorded amount, the Company would make an adjustment to the valuation allowance, which would reduce the provision for income taxes.

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. Based on this assessment, as of September 30, 2013, reduction in the valuation allowance in the amount of $3.7 million has been recorded in order to measure only the portion of the deferred tax asset that more likely than not will be realized. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income during the carry forward period are reduced or if objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as expectations for growth.

The Company adopted ASC 740, Accounting for Uncertainty in Income Taxes on January 1, 2007. As per ASC 740, a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits. The Company did not have any material unrecognized tax benefits or uncertain tax positions at September 30, 2013.

9. Commitments and Contingencies

Litigation

From time to time, the Company may be involved in litigation in the normal course of business. As of the date of these financial statements, the Company is not aware of any material legal proceedings pending or threatened against the Company.

Indemnification and Product Warranty

The Company indemnifies certain customers, suppliers and subcontractors for attorney fees and damages and costs awarded against these parties in certain circumstances in which products are alleged to infringe third party intellectual property rights, including patents, trade secrets, trademarks or copyrights. In all cases, there are limits on and exceptions to the potential liability for indemnification relating to intellectual property infringement claims. The Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. As of September 30, 2013, the Company has not paid any claim or been required to defend any action related to indemnification obligations, and accordingly, the Company has not accrued any amounts for such indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations.

The Company generally warrants products against defects in materials and workmanship and non-conformance to specifications for varying lengths of time. If there is a material increase in customer claims compared with historical experience, or if costs of servicing warranty claims are greater than expected, the Company may record a charge against cost of revenues. The Company accrued $0.06 million and $0.02 million for warranty reserves at each of September 30, 2013 and 2012, respectively.

Operating Leases

The Company leases office space under long-term operating leases expiring at various dates through 2017.

The Company’s aggregate future minimum facility lease payments are as follows (in thousands):

Years ending December 31:
2013 (remaining three months of the year)	$	182
2014		680
2015		239
2016		22
2017 and after		2
Total	$	1,125

10. Bank Loans

In November 2004, the Company entered into a ten-year loan of $0.5 million in Taiwan with an interest rate of 2.3% for the first two years and 3.6% for the following years. In November 2006, the Company entered into a seven-year loan of $0.2 million in Taiwan with an interest rate of 2.8%. Both loans were secured by the Company’s building in Taiwan. In September 2007, the Company also entered a five-yearequipment loan of $0.1 million with an interest rate of 3.68%. In July 2012, the Company paid off all of the loans.

11. Related Party Transactions

As of September 30, 2013, based on information filed with the Securities and Exchange Commission on January 4, 2002 for the year ended December 31, 2000, Foxconn Holding Limited (“Foxconn”) and Hon Hai Precision Industry Co. Ltd. (“Hon Hai”) held 17.46% of the Company’s common stock. In the normal course of business, the Company sells products to and purchases raw materials from Hon Hai, who is the parent company of Foxconn. These transactions were made at prices and terms consistent with those of unrelated third parties.

There were no sales of products to Hon Hai in either of the three or nine months ended September 30, 2013. Purchases of raw materials from Hon Hai were $0.5 million and $1.2 million for the three and nine months ended September 30, 2013, respectively. No amounts were due from Hon Hai at September 30, 2013. Amounts due to Hon Hai were $0.4 million at September 30, 2013.

Sales of products to Hon Hai were zero and $0.06 million for the three and nine months ended September 30, 2012, respectively. Purchases of raw materials from Hon Hai were $0.2 million and $0.8 million for the three and nine months ended September 30, 2012, respectively. Amounts due from Hon Hai were $0.03 million for both the three and nine months ended September 30, 2012. Amounts due to Hon Hai were $0.3 million for both the three and nine months ended September 30, 2012.

12. Fair Value of Financial instruments

U.S. GAAP defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact a purchase or sale and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability.

The Company uses a fair value hierarchy established by U.S. GAAP that established a three-tiered fair value hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable to prioritize inputs used to measure fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is available and significant to the fair value measurement. Those tiers are defined as follows:

	Level 1 —	inputs are quoted prices in active markets for identical assets or liabilities.

	Level 2 —	inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly.

	Level 3 —	inputs are unobservable and shall be used to the extent that observable inputs are not available in the overall fair value measurement.

In 2012, the Company adopted Accounting Standards Update (“ASU”) No. 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”)” (“ASU 2011-04”). ASU 2011-04 includes common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. ASU 2011-04 requires a reporting entity to disclose the reason for the measurement, where for recurring fair value measurements, the reason for measuring an asset or liability at fair value is often that either 1) it is required under other existing U.S. GAAP codification guidance or 2) the reporting entity has elected the fair value option under ASC 825. In regards to the Company, it is required under U.S. GAAP.

ASU 2011-04 also requires reporting entities to disclose the following information for all Level 2 and Level 3 fair value measurement, where it requires that an entity must disclose a description of the valuation techniques and the inputs used in those measurements.

For its Level 2 investments, the Company uses quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset.

For all Level 3 measurements, ASU 2011-04 requires that an entity disclose quantitative information about the significant unobservable inputs used in those measurements. The Company has no Level 3 measurements.

In addition, ASU 2011-04 requires reporting entities to make disclosure about amounts and reasons for all the transfers out of Level 1 and Level 2 fair value measurements. The Company had no such transfers for the nine months ended September 30, 2013.

The adoption of ASU 2011-04 did not have a significant impact on the Company’s financial statements.

In accordance with the U.S. GAAP Codification Topic 820, the following table represent the fair value hierarchy for the Company’s financial assets (investments) measured at fair value on a recurring basis as of September 30, 2013:

	Fair Value Measurements at
	Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
	Balance at		Markets for		Observable		Unobservable
	September 30,		Identical Assets		Inputs		Inputs
	2013		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market mutual funds	$	2,277	$	2,277	$	-	$	-
Marketable Securities:
Time deposits		17,284		17,284		-		-
Corporate bonds		13,153		-		13,153		-
Long-term investments:
Time deposits		10,408		10,408		-		-
Total	$	43,122	$	29,969	$	13,153	$	-

As of September 30, 2013, the Company held investments in corporate bonds, certificates of deposit, and money market securities. The Company’s cash and cash equivalents consist of investments with original maturities of 90 days or less from the date of purchase. The Company’s short-term investments consist of corporate bonds and certificates of deposit with original maturities of 91 days or more from the date of purchase. The Company’s long-term investments comprise certificates of deposit with original maturities of 365 days or more from the date of purchase.

13. Geographic Segment Information

The Company operates in a single industry segment. This industry segment is characterized by rapid technological change and significant competition.

The following is a summary of the Company’s revenues generated by geographic segments, revenues generated by product lines and identifiable assets located in these segments (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Revenues
North America	$	13,085	$	7,184	$	32,260	$	20,435
Europe		4,379		2,327		10,519		6,178
Asia		5,610		2,879		11,487		7,839
	$	23,074	$	12,390	$	54,266	$	34,452

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Revenues
Connectivity Products	$	17,572	$	8,307	$	40,990	$	24,591
Optical Passive Products		5,502		4,083		13,276		9,861
	$	23,074	$	12,390	$	54,266	$	34,452

	September 30,		December 31,
	2013		2012
Property and Equipment
United States	$	42	$	43
Taiwan		4,769		3,473
China		5,481		4,192
	$	10,292	$	7,708

14. Subsequent Event

On November 1, 2013, the Company held a special meeting of its stockholders (the “Special Meeting”) at which stockholders approved an increase in the number of shares of authorized Common Stock from 20,000,000 to 100,000,000 shares and an increase by 900,000 the number of shares of Common Stock available for issuance under the 2000 Stock Incentive Plan.

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

When used in this Report, the words “expects,” “anticipates,” “believes”, “estimates,” “plans,” “intends,” “could,” “will,” “may” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include statements as to our operating results, revenues, sources of revenues, cost of revenues, gross margin, profitability, the amount and mix of investments, expenditures and expenses, our liquidity and the adequacy of our capital resources, our uses of cash, the impact of the economic environment on our business, exposure to interest rate or currency fluctuations, anticipated working capital and capital expenditures, reliance on our connectivity products, our cash flow, trends in average selling prices, our reliance on the commercial success of our optical passive products, plans for future products and enhancements of existing products, features, benefits and uses of our products, demand for our products, our success being tied to relationships with key customers, industry trends and market demand, our ability to protecting our intellectual property, the potential benefit of indemnification agreements, increases in the number of possible requests for licenses and patent infringement claims, our competitive position, sources of competition, consolidation in our industry, our international strategy, inventory management, our factory utilization levels, our employee relations, the adequacy of our internal controls, and the effect of recent, future and changing accounting pronouncements and our critical accounting policies, estimates, models, judgments and assumptions on our financial results. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expected. These risks and uncertainties include, but are not limited to, those risks discussed elsewhere in this report, as well as risks related to the development of the metropolitan, last mile access, and enterprise networks, customer acceptance of our products, our ability to retain and obtain customers, industry-wide overcapacity and shifts in supply and demand for optical components and modules, our ability to meet customer demand and manage inventory,fluctuations in demand for our products, declines in average selling prices, development of new products by us and our competitors, increased competition, inability to obtain sufficient quantities of raw materials or components, loss of a key supplier, integration of acquired businesses or technologies, financial stability in foreign markets, foreign currency exchange rates, interest rates, costs associated with being a public company, failure to meet customer requirements, our ability to license intellectual property on commercially reasonable terms, the impact of the economic environment, and the risks set forth below under Part II, Item 1A, “Risk Factors.” These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and Notes thereto.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations is based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, bad debts, inventories, asset impairments, income taxes, contingencies, and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values for assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

For additional information regarding our critical accounting policies and estimates, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2012.

Overview

We were founded in December 1995 and commenced operations to design, manufacture and market fiber optic interconnect products, which we call our connectivity products. We started selling our optical passive products in July 2000. Since their introduction, sales of optical passive products have fluctuated with the overall market for these products. We market and sell our products predominantly through our direct sales force.

Our connectivity products contributed revenues of $17.6 million, or 76.2% and $8.3 million, or 67.0% for the three months ended September 30, 2013 and 2012, respectively. Our optical passive products contributed revenues of $5.5 million, or 23.8% and $4.1 million, or 33.0% for the three months ended September 30, 2013 and 2012, respectively.

Our connectivity products contributed revenues of $41.0 million, or 75.5% and $24.6 million, or 71.4% for the nine months ended September 30, 2013 and 2012, respectively. Our optical passive products contributed revenues of $13.3 million, or 24.5% and $9.9 million, or 28.6% for the nine months ended September 30, 2013 and 2012, respectively.

In the three months ended September 30, 2013 and 2012, our 10 largest customers comprised 79.1% and 66.3% of our revenues, respectively. For the three months ended September 30, 2013, two customers accounted for 40.1% and 11.2% of our total revenues. For the three months ended September 30, 2012, three customers accounted for 14.1%, 11.0% and 10.1% of our total revenues.

In the nine months ended September 30, 2013 and 2012, our 10 largest customers comprised 74.5% and 62.9% of our revenues, respectively. For the nine months ended September 30, 2013, two customers accounted for 32.4% and 10.4% of our revenues. For the nine months ended September 30, 2012, no customer accounted for 10% or more of our revenues.

Our cost of revenues consists of raw materials, components, direct labor, manufacturing overhead and production start-up costs. We expect that our cost of revenues as a percentage of revenues will fluctuate from period to period based on a number of factors including:

changes in manufacturing volume;
costs incurred in establishing additional manufacturing lines and facilities;
inventory write-downs and impairment charges related to manufacturing assets;
mix of products sold;
changes in our pricing and pricing from our competitors;
mix of sales channels through which our products are sold; and
mix of domestic and international sales.

Research and development expenses consist primarily of salaries and related personnel expenses, fees paid to outside service providers, materials costs, test units, facilities, overhead and other expenses related to the design, development, testing and enhancement of our products. We expense our research and development costs as they are incurred. We believe that a significant level of investment for product research and development is required to remain competitive.

Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales and technical support functions, as well as costs associated with trade shows, promotional activities and travel expenses. We intend to continue to invest in our sales and marketing efforts, both domestically and internationally, in order to increase market awareness and to generate sales of our products. However, we cannot be certain that our expenditures will result in higher revenues. In addition, we believe that our future success depends upon establishing successful relationships with a variety of key customers.

General and administrative expenses consist primarily of salaries and related expenses for executive, finance, administrative, accounting and human resources personnel, insurance and professional fees for legal and accounting services.

Results of Operations

The following table sets forth the relationship between various components of operations as a percentage of revenues for the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of revenues	61.6		64.4		62.1		65.9
Gross profit	38.4		35.6		37.9		34.1
Operating expenses:
Research and development	4.5		6.6		5.0		7.1
Sales and marketing	3.6		5.0		4.3		5.7
General and administrative	5.8		8.7		6.7		9.5
Total operating expenses	13.9		20.3		16.0		22.3
Income from operations	24.5		15.3		21.9		11.8
Interest and other income, net	0.8		1.6		0.9		1.4
Net income before tax	25.3		16.9		22.8		13.2
Income tax	(0.9	)	(1.6	)	(1.1	)	(1.5	)
Net income	24.4	%	15.3	%	21.7	%	11.7	%

Revenues.Revenues were $23.1 million and $12.4 million for the three months ended September 30, 2013 and 2012, respectively. Revenues increased 86.2% in the three months ended September 30, 2013 from the same period in 2012. Revenues were $54.3 million and $34.5 million for the nine months ended September 30, 2013 and 2012, respectively. Revenues increased 57.5% in the nine months ended September 30, 2013 from the same period in 2012. The increase for the three and nine months ended September 30, 2013 was mainly due to increased orders from our existing customers and higher volume shipments of telecom and enterprise applications related products.

Cost of Revenues.Cost of revenues was $14.2 million and $8.0 million for the three months ended September 30, 2013 and 2012, respectively. Cost of revenues as a percentage of revenues decreased to 61.6% for the three months ended September 30, 2013 from 64.4% for the three months ended September 30, 2012. Cost of revenues was $33.7 million and $22.7 million for the nine months ended September 30, 2013 and 2012, respectively. Cost of revenues as a percentage of revenues decreased to 62.1% for the nine months ended September 30, 2013 from 65.9% for the nine months ended September 30, 2012. The lower cost of revenues percentage for the three and nine months ended September 30, 2013 resulted from increased factory utilization due to higher product sales.

Gross Profit.Gross profit increased to $8.9 million, or 38.4% of revenues, for the three months ended September 30, 2013 from $4.4 million, or 35.6% of revenues, for the same period in 2012. Gross profit increased to $20.5 million, or 37.9% of revenues, for the nine months ended September 30, 2013 from $11.8 million, or 34.1% of revenues, for the same period in 2012. For the three and nine months ended September 30, 2013, the higher gross profit was due to the higher utilization of our factories as a result of increased volume shipments to our customers.

Research and Development Expenses. Research and development expenses were $1.0 million and $0.8 million for the three months ended September 30, 2013 and 2012, respectively. Research and development expenses increased to $2.7 million for the nine months ended September 30, 2013 from $2.5 million for the same period in 2012. The higher research and development expenses were due to higher capital investments for new product development, higher costs associated with testing our products and higher stock based compensation charges.

As a percentage of revenues, research and development expenses decreased to 4.5% in the three months ended September 30, 2013 from 6.6% for the same period in 2012. As a percentage of revenues, research and development expenses decreased to 5.0% in the nine months ended September 30, 2013 from 7.1% for the same period in 2012. The lower research and development expenses as a percentage of revenues were mainly due to increased revenue levels. We expect research and development expenses will increase as we intend to continue to invest in our research and product development efforts.

Sales and Marketing Expenses. Sales and marketing expenses increased to $0.8 million for the three months ended September 30, 2013 compared to $0.6 million for the three months ended September 30, 2012. Sales and marketing expenses increased to $2.3 million for the nine months ended September 30, 2013 from $2.0 million for the same period in 2012. The higher sales and marketing expenses were due to new hires and stock based compensation charges.

As a percentage of revenues, sales and marketing expenses were decreased to 3.6% in the three months ended September 30, 2013 from 5.0% for the same period in 2012. As a percentage of revenues, sales and marketing expenses decreased to 4.3% in the nine months ended September 30, 2013 from 5.7% for the same period in 2012. The lower sales and marketing expenses as a percentage of revenues was mainly due to increased revenue levels. We expect sales and marketing expenses will remain relatively flat in the next quarter.

General and Administrative Expenses. General and administrative expenses increased to $1.3 million for the three months ended September 30, 2013 compared to $1.1 million for the three months ended September 30, 2012. General and administrative expenses increased to $3.6 million for the nine months ended September 30, 2013 from $3.3 million for the same period in 2012. The increases were mainly due to higher stock based compensation charges.

As a percentage of revenues, general and administrative expenses decreased to 5.8% in the three months ended September 30, 2013 from 8.7% for the same period in 2012. As a percentage of revenues, general and administrative expenses decreased to 6.7% in the nine months ended September 30, 2013from 9.5% for the same period in 2012. The lower general and administrative expenses as a percentage of revenues was mainly due to increased revenue levels. We expect general and administrative expenses will remain relatively flat in the next quarter.

Stock-Based Compensation. Total stock-based compensation increased to $0.6 million for the three months ended September 30, 2013 compared to $0.3 million for the three months ended September 30, 2012. Total stock-based compensation increased to $1.3 million for the nine months ended September 30, 2013 from $0.8 million for the same period in 2012. This increase was due to RSUs granted in June 2013 and amortization stock option granted in April and October 2012, and resulted in higher stock-based compensation expense.

Interest and Other Income, Net.Interest and other income, net, was $0.2 million for each of the three months ended September 30, 2013 and 2012. Interest and other income, net, was $0.5 million for each of the nine months ended September 30, 2013 and 2012. These amounts consisted primarily of interest income which fluctuated based on cash balances and changes in interest rates.

Income Tax Expense.Income tax expense was approximately $0.2 million for each of the three months ended September 30, 2013 and 2012. Income tax expense was $0.5 million for each of the nine months ended September 30, 2013 and 2012.

Liquidity and Capital Resources

At September 30, 2013, we had cash and cash equivalents of $15.2 million and short-term investments of $30.4 million. Long-term investments at September 30, 2013 were $10.4 million.

Net cash provided by operating activities was $12.2 million for the nine months ended September 30, 2013. The increase in net cash provided by operating activities was primarily due to net income of $11.8 million, an increase in accounts payable of $5.7 million, an increase in accrued expenses of $1.9 million, and contribution from adjustment for non-cash charges, including depreciation and amortization and stock based compensation of $2.8 million. These were offset by a $4.3 million increase in accounts receivable, a $3.3 million increase in inventory, a $1.0 million increase in prepaid expenses and $1.3 million of deferred compensation expenses related to RSUs.

Net cash provided by operating activities was $5.3 million for the nine months ended September 30, 2012. Net cash provided by operating activities was primarily due to net income of $4.0 million, an increase in accounts payable of $2.6 million, an increase in accrued expenses and other liabilities of $0.7 million, and contribution from adjustment for non-cash charges, including depreciation and amortization and stock based compensation of, $2.0 million. These were offset by a $1.7 million increase in accounts receivable, a $1.1 million increase in prepaid expenses, a $0.5 million increase in inventory and $0.6 million of deferred compensation expenses related to RSUs.

Net cash used in investing activities was $6.1 million for the nine months ended September 30, 2013. This resulted from $2.1 million in net purchases of short-term investments and $4.0 million of equipment purchases.

Net cash used in investing activities was $9.2 million for the nine months ended September 30, 2012. This resulted primarily from $8.3 million in net purchases of short-term investments and $0.7 million of equipment purchases.

Net cash provided by financing activities was $4.5 million for the nine months ended September 30, 2013. Net cash provided by financing activities was primarily due to proceeds of $5.4 million from the exercise of options to purchase our common stock and the sale of our common stock through our ESPP, which was offset by a $0.9 million used to repurchase common stock pursuant to our stock repurchase program.

Net cash used in financing activities was $1.9 million for the nine months ended September 30, 2012. Net cash used in financing activities was primarily due to $2.4 million used to repurchase common stock pursuant to our stock repurchase program and the repayment of $0.2 million in bank borrowings, which was offset in part by proceeds from the sale of our common stock through our ESPP.

We believe that our current cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.

However, our future growth, including any potential acquisitions, may require additional funding. If cash generated from operations is insufficient to satisfy our long-term liquidity requirements, we may need to raise capital through additional equity or debt financings, additional credit facilities, strategic relationships or other arrangements. If additional funds are raised through the issuance of securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the terms of any debt facility could impose restrictions on our operations. The sale of additional equity or debt securities could result in additional dilution to our stockholders, and additional funding may not be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of our planned product development and marketing efforts. Strategic arrangements, if necessary to raise additional funds, may require us to relinquish our rights to certain of our technologies or products. Our failure to raise capital when needed could harm our business, financial condition and operating results.

Off Balance Sheet Arrangements

We did not have any off-balance sheet arrangements at September 30, 2013.

Contractual Obligations

The lease on our corporate headquarters in Sunnyvale, California, had a six-year term commencing on July 22, 2004. In June 2010, we renewed the lease for an 18,088 square foot facility in the same building, which lease will expire in January 2016.

In Taiwan, we lease a total of approximately 38,800 square feet in one facility located in Tu-Cheng City, Taiwan. These leases expire at various times from December 2014 to December 2018. In December 2000, we purchased approximately 8,200 square feet of space immediately adjacent to our leased facility for $0.8 million, bringing the total square footage to approximately 47,000 square feet.

We lease a 132,993 square foot facility in Shenzhen, China, which lease will expire in October 2014.

Recent Accounting Pronouncements

See Note 2 of our Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for information on recent accounting pronouncements.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4: CONTROLS AND PROCEDURES

(a)Evaluation of disclosure controls and procedures.We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Acting Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

(b) Changes in internal controls.There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation described in Item 4(a) above that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1A: RISK FACTORS

We have a history of losses, may experience future losses and may not be able to generate sufficient revenues in the future to sustain profitability.

We had net income of $5.6 million in the quarter ended September 30, 2013. Although we generated a profit in the quarter, we may not be able to sustain profitability and our cash flows may be negative again in the future. As of September 30, 2013, we had an accumulated deficit of $42.9 million.

We continue to experience fluctuating demand for our products. If demand for our products declines, we may not be able to decrease our expenses on a timely basis or at levels that offset any such decreases. If demand for our products continues to increase in the future, we may incur significant and increasing expenses for expansion of our manufacturing operations, research and development, sales and marketing, and administration, and in expanding our direct sales and distribution channels. Given the rate at which competition in our industry intensifies and the fluctuations in demand for our products, we may not be able to adequately control our costs and expenses or achieve or maintain adequate operating margins. As a result, to maintain profitability, we will need to generate and sustain substantially higher revenues while maintaining reasonable cost and expense levels. We may not be able to sustain profitability on a quarterly or an annual basis.

Our connectivity products have historically represented a significant part of our revenues, and if we are unsuccessful in selling our optical passive products, our business may be harmed.

Sales of our connectivity products accounted for over 76.2% of our revenues in the quarter ended September 30, 2013 and a majority of our historical revenues. We expect to substantially depend on these products for the majority of our near-term revenues. We have in the past, and may in the future experience declines in average selling prices. Any significant decline in the price of, or demand for, these products, or failure to increase their market acceptance, would seriously harm our business. In addition, we believe that our future growth and a significant portion of our future revenues will depend on the commercial success of our optical passive products. If demand for these products does not continue to increase and our target customers do not continue to adopt and purchase our optical passive products, our revenues may decline.

Continuing weak general economic or business conditions may have a negative impact on our business.

Continuing concerns over inflation, deflation, another recession, energy costs, geopolitical issues, the availability and cost of credit, Federal budget proposals, the Federal deficit and credit rating, unemployment, global economic instability, slowing growth in China, and an uncertain real estate market in the U.S. have contributed to increased volatility and diminished expectations for the global economy and expectations of slower global economic growth going forward. These factors, combined with volatile oil prices, declining business and consumer confidence, a volatile stock market and increased unemployment, have precipitated an economic slowdown and recession. If the economic climate in the U.S. and abroad does not improve or continues to deteriorate, our business, including our customers and our suppliers, could be negatively affected, resulting in a negative impact on our revenues.

We depend on a small number of customers for a significant portion of our revenues and the loss of, or a significant reduction in orders from, any of these customers, would significantly reduce our revenues and harm our operating results.

In the quarters ended September 30, 2013 and 2012, our 10 largest customers comprised 79.1% and 66.3% of our revenues, respectively. In the nine months ended September 30, 2013 and 2012, our 10 largest customers comprised 74.5% and 62.9% of our revenues, respectively. Two customers accounted for 40.1% and 11.2% of our revenues for the three months ended September 30, 2013. Three customers accounted for 14.1%, 11.0% and 10.1% of our revenues for the three months ended September 30, 2012. Two customers accounted for 32.4% and 10.4% of our revenues for the nine months ended September 30, 2013.

We derive a significant portion of our revenues from a small number of customers, and we anticipate that we will continue to do so in the foreseeable future. These customers may decide not to purchase our products at all, to purchase fewer products than they did in the past, or to alter their purchasing patterns in some other way. The loss of any significant customer, a significant reduction in sales we make to a customer, or any problems collecting receivables from one or more significant customers would likely harm our financial condition and results of operations.

Our quarterly and annual financial results have historically fluctuated due primarily to introduction of, demand for, and sales of our products, and future fluctuations may cause our stock price to decline.

We believe that period-to-period comparisons of our operating results are not a good indication of our future performance. Our quarterly operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a number of factors. For example, the timing and expenses associated with product introductions and establishing additional manufacturing lines and facilities, changes in manufacturing volume, declining average selling prices of our products, the timing and extent of product sales, the mix of domestic and international sales, the mix of sales channels through which our products are sold, the mix of products sold and significant fluctuations in demand for our products have caused our operating results to fluctuate in the past. Because we incur operating expenses based on anticipated revenue levels; and a significant percentage of our expenses are fixed in the short term, any delay in generating or recognizing revenues or any decrease in revenues could significantly harm our quarterly results of operations. Other factors, many of which are more fully discussed elsewhere in this report, may also cause our results to fluctuate. Many of the factors that may cause our results to fluctuate are outside of our control. If our quarterly or annual operating results do not meet the expectations of investors and securities analysts, the trading price of our common stock could significantly decline.

If we cannot attract more optical communications equipment manufacturers to purchase our products, we may not be able to increase or sustain our revenues.

Our future success will depend on our ability to migrate existing customers to our new products and our ability to attract additional customers. Some of our present customers are relatively new companies. The growth of our customer base could be adversely affected by:

customer unwillingness to implement our products;
any delays or difficulties that we may incur in completing the development and introduction of our planned products or product enhancements;
the success of our customers;
excess inventory in the telecommunications industry;
new product introductions by our competitors;
any failure of our products to perform as expected; or
any difficulty we may incur in meeting customers’ delivery requirements or product specifications.

The fluctuations in the economy have affected the telecommunications industry. Telecommunications companies have cut back on their capital expenditure budgets, which has and may continue to further decrease demand for equipment and parts, including our products. This decrease has had and maycontinue to have an adverse effect on the demand for fiber optic products and negatively impact the growth of our customer base.

We are exposed to risks and increased expenses and business risk as a result of Restriction on Hazardous Substances, or RoHS, directives.

Following the lead of the European Union, or EU, various governmental agencies have either already put into place or are planning to introduce regulations that regulate the permissible levels of hazardous substances in products sold in various regions of the world. For example, the RoHS directive for EU took effect on July 1, 2006. The labeling provisions of similar legislation in China went into effect on March 1, 2007. Consequently, many suppliers of products sold into the EU have required their suppliers to becompliant with the new directive. Many of our customers have adopted this approach and have required our full compliance. Though we have devoted a significant amount of resources and effort planning and executing our RoHS program, it is possible that some of our products might be incompatible with such regulations. In such event, we could experience the following consequences: loss of revenue, damaged reputation, diversion of resources, monetary penalties, and legal action.

The market for fiber optic components is increasingly competitive, and if we are unable to compete successfully our revenues could decline.

The market for fiber optic components is intensely competitive. We believe that our principal competitors are the major manufacturers of optical components and integrated modules, including vendors selling to third parties and business divisions within communications equipment suppliers. Our principal competitors in the components market include Oclaro Corp., JDS Uniphase Corp., Oplink Communications Inc., Senko Advanced Components and TE Connectivity. We believe that we primarily compete with diversified suppliers for the majority of our product line and to a lesser extent with niche companies that offer a more limited product line. Competitors in any portion of our business may also rapidly become competitors in other portions of our business.

Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing, manufacturing and other resources than we do. As a result, these competitors may be able to respond more quickly to new or emerging technologies and to changes in customer requirements, to devote more resources to the development, promotion and sale of products, to negotiate lower prices on raw materials and components, or to deliver competitive products at lower prices.

Several of our existing and potential customers are also current and potential competitors of ours. These companies may develop or acquire additional competitive products or technologies in the future and subsequently reduce or cease their purchases from us. In light of the consolidation in the optical networking industry, we also believe that the size of suppliers will be an increasingly important part of a purchaser’s decision-making criteria in the future. We may not be able to compete successfully with existing or new competitors, and we cannot ensure that the competitive pressures we face will not result in lower prices for our products, loss of market share, or reduced gross margins, any of which could harm our business.

New and competing technologies are emerging due to increased competition and customer demand. The introduction of products incorporating new or competing technologies or the emergence of new industry standards could make our existing products noncompetitive. For example, there are technologies for the design of wavelength division multiplexers that compete with the technology that we incorporate in our products. If our products do not incorporate technologies demanded by customers, we could lose market share causing our business to suffer.

If we fail to effectively manage our operations, specifically given the past history of sudden and dramatic downturn in demand for our products, our operating results could be harmed.

As of September 30, 2013, we had 34 full-time employees in Sunnyvale, California, 365 full-time employees in Taiwan, and 1199 full-time employees in China. Matching the scale of our operations with demand fluctuations, combined with the challenges of expanding and managing geographically dispersed operations, has placed, and will continue to place, a significant strain on our management and resources. To manage the expected fluctuations in our operations and personnel, we will be required to:

improve existing and implement new operational, financial and management controls, reporting systems and procedures;
hire, train, motivate and manage additional qualified personnel, especially if we experience a significant increase in demand for our products;

effectively expand or reduce our manufacturing capacity, attempting to adjust it to customer demand; and
effectively manage relationships with our customers, suppliers, representatives and other third parties.

In addition, we will need to continue coordinate our domestic and international operations and establish and maintain the necessary infrastructure to implement our international strategy. If we are not able to manage our operations in an efficient and timely manner, our business will be severely harmed.

Our success also depends, to a large degree, on the efficient and uninterrupted operation of our facilities. We have expanded our manufacturing facilities in China and manufacture many of our products there. Our facility in Taiwan also houses a substantial portion of our manufacturing operations. There is significant political tension between Taiwan and China. If there is an outbreak of hostilities between Taiwan and China, our manufacturing operations may be disrupted or we may have to relocate our manufacturing operations. Relocating a portion of our employees could cause temporary disruptions in our operations and divert management’s attention.

Because of the time it takes to develop fiber optic components, we incur substantial expenses for which we may not earn associated revenues.

The development of new or enhanced fiber optic products is a complex and uncertain process. We may experience difficulties in design, manufacturing, marketing and other areas that could delay or prevent the development, introduction or marketing of new products and enhancements. Development costs and expenses are incurred before we generate revenues from sales of products resulting from these efforts. Our research and development expenses were $1.0 million and $2.7 million for the three and nine months ended September 30, 2013, respectively. We intend to continue to invest in our research and product development efforts and the amount of our future investments may be substantial, which could have a negative impact on our earnings in future periods.

If we are unable to develop new products and product enhancements that achieve market acceptance, sales of our fiber optic components could decline, which could reduce our revenues.

The communications industry is characterized by continued changing technology, frequent new product introductions, changes in customer requirements, evolving industry standards and, more recently, significant variations in customer demand. Our future success depends on our ability to anticipate market needs and develop products that address those needs. As a result, our products could quickly become obsolete if we fail to predict market needs accurately or develop new products or product enhancements in a timely manner. Our failure to predict market needs accurately or to develop new products or product enhancements in a timely manner will harm market acceptance and sales of our products. If the development or enhancement of these products or any other future products takes longer than we anticipate, or if we are unable to introduce these products to market, our sales will not increase. Even if we are able to develop and commercially introduce them, these new products may not achieve the widespread market acceptance necessary to provide an adequate return on our investment.

Current and future demand for our products depends on the continued growth of the Internet and the communications industry, which is experiencing consolidation, realignment, and fluctuating demand for fiber optic products.

Our future success depends on the continued growth of the Internet as a widely used medium for communications and commerce, and the growth of optical networks to meet the increased demand for capacity to transmit data, or bandwidth. If the Internet does not continue to expand as a medium for communications and commerce, the need to significantly increase bandwidth across networks and the market for fiber optic components may not continue to develop. If this growth does not continue, sales of our products may decline, which would adversely affect our revenues. Our customers have experiencedan oversupply of inventory due to fluctuating demand for their products that has resulted in inconsistent demand for our products. Future demand for our products is uncertain and will depend heavily on the continued growth and upgrading of optical networks, especially in the metropolitan, last mile, and enterprise access segments of the networks.

Inconsistent spending by telecommunication companies over the past several years has resulted in fluctuating demand for our products. The rate at which communication service providers and other fiber optic network users have built new fiber optic networks or installed new systems in their existing fiber optic networks has fluctuated in the past and these fluctuations may continue in the future. These fluctuations may result in reduced demand for new or upgraded fiber optic systems that utilize our products and therefore, may result in reduced demand for our products. Declines in the development of new networks and installation of new systems have resulted in the past in a decrease in demand for our products, an increase in our inventory, and erosion in the average selling prices of our products.

The communications industry is experiencing consolidation and realignment, as industry participants seek to capitalize on the rapidly changing competitive landscape developing around the Internet and new communications technologies such as fiber optic networks. As the communications industry consolidates and realigns to accommodate technological and other developments, our customers may consolidate or align with other entities in a manner that results in a decrease in demand for our products.

We have experienced fluctuations in market demand due to overcapacity in our industry and an economy that is stymied by current financial and economic conditions, international terrorism, war and political instability.

The United States economy has experienced and continues to experience significant fluctuations in consumption and demand. We have in the past and may in the future experience decreases in demand for our products due to a weak domestic and international economy as the fiber optics industry copes with the effects of oversupply of products, international terrorism, war and political and economic instability. Even if the general economy experiences a recovery, the activity of the United States telecommunications industry may lag behind the recovery of the overall United States economy.

The optical networking component industry often experiences declining average selling prices and declines in average selling prices of our products could cause our gross margins to decline.

The optical networking component industry often experiences declining average selling prices as a result of increasing competition and from pricing pressures resulting in greater unit volumes purchases as communication service providers continue to deploy fiber optic networks. We expect that average selling prices will continue to decrease over time in response to new product and technology introductions by us or competitors, price pressures from significant customers, greater manufacturing efficiencies achieved through increased automation in the manufacturing process and inventory build-up due to decreased demand. Average selling price declines may contribute to a decline in our gross margins, which could harm our results of operations.

We will not attract new orders for our fiber optic components unless we can deliver sufficient quantities of our products to optical communications equipment manufacturers.

Communications service providers and optical systems manufacturers typically require that suppliers commit to provide specified quantities of products over a given period of time. If we are unable to commit to deliver quantities of our products to satisfy a customer’s anticipated needs, we will lose the order and the opportunity for significant sales to that customer for a lengthy period of time. In addition, we would be unable to fill large orders if we do not have sufficient manufacturing capacity to enable us to commit to provide customers with specified quantities of products. However, if we build our manufacturing capacity and inventory in excess of demand, as we have done in the past, we may produce excess inventory that may have to be reserved or written off.

Because we experience long lead times for materials and components, we may not be able to effectively manage our inventory levels or manufacturing capacity, which could harm our operating results.

Because we experience long lead times for materials and components and are often required to purchase significant amounts of materials and components far in advance of product shipments, we may not effectively manage our inventory levels, which could harm our operating results. Alternatively, if we underestimate our raw material requirements, we may have inadequate inventory, which could result in delays in shipments and loss of customers. If we purchase raw materials and increase production in anticipation of orders that do not materialize or that shift to another quarter, we will, as we have in the past, have to carry or write off excess inventory and our gross margins will decline. Both situations could cause our results of operations to be below the expectations of investors and public market analysts, which could, in turn, cause the price of our common stock to decline. The time our customers require to incorporate our products into their own can vary significantly and generally exceeds several months, which further complicates our planning processes and reduces the predictability of our forecasts. Even if we receive these orders, the additional manufacturing capacity that we add to meet our customer’s requirements may be underutilized in a subsequent quarter.

If we are unable to maintain effective internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our reported financial information and the market price of our common stock may be negatively affected.

As a public company, we are required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 which requires that we evaluate and determine the effectiveness of our internal control over financial reporting and provide a management report on the internal control over financial reporting. We are required to perform an assessment of our internal control over financial reporting and to disclose management’s assessment of the same under Section 404(a) of Sarbanes-Oxley. We have implemented an ongoing program to perform the system and process evaluation and testing we believe to be necessary to comply with this requirement, however, we cannot assure you that we will be successful in our efforts. If we have a material weakness in our internal control over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, our management will be unable to conclude that our internal control over financial reporting is effective. Beginning with our annual report for the year ending December 31, 2013, our independent registered public accounting firm will be required to issue an attestation report on the effectiveness of our internal control over financial reporting. Even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may conclude that there are material weaknesses with respect to our internal controls or the level at which our internal controls are documented, designed, implemented or reviewed. If we are unable to conclude that our internal control over financial reporting is effective or if our auditors were to express an adverse opinion on the effectiveness of our internal control over financial reporting because we had one or more material weaknesses, investors could lose confidence in the accuracy and completeness of our financial disclosures, which could cause the price of our common stock to decline. Internal control deficiencies could also result in a restatement of our financial results.

We depend on key personnel to operate our business effectively in the rapidly changing fiber optic components market, and if we are unable to hire and retain appropriate management and technical personnel, our ability to develop our business could be harmed.

Our success depends to a significant degree upon the continued contributions of the principal members of our technical sales, marketing, engineering and management personnel, many of whom perform important management functions and would be difficult to replace. We particularly depend upon the continued services of our executive officers, particularly Peter Chang, our President and Chief Executive Officer; David Hubbard, our Executive Vice President, Sales and Marketing; Anita Ho, our Acting Chief Financial Officer; and other key engineering, sales, marketing, finance, manufacturing and support personnel. In addition, we depend upon the continued services of key management personnel at our Taiwanese subsidiary and at our facility in China. None of our officers or key employees is bound by an employment agreement for any specific term, and may terminate their employment at any time. We do not have “key person” life insurance policies covering any of our employees.

Our ability to continue to attract and retain highly skilled personnel will be a critical factor in determining whether we will be successful in the future. We may have difficulty hiring skilled engineers at our manufacturing facilities in the United States, Taiwan, and China. If we are not successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs, our business may be harmed.

If we are not able to achieve acceptable manufacturing yields and sufficient product reliability in the production of our fiber optic components, we may incur increased costs and delays in shipping products to our customers, which could impair our operating results.

Complex and precise processes are required for the manufacture of our products. Changes in our manufacturing processes or those of our suppliers, or the inadvertent use of defective materials, could significantly reduce our manufacturing yields and product reliability. Because the majority of our manufacturing costs are relatively fixed, manufacturing yields are critical to our results of operations. Lower than expected production yields could delay product shipments and impair our operating results. We may not obtain acceptable yields in the future.

In some cases, existing manufacturing techniques, which involve substantial manual labor, may not allow us to cost-effectively meet our production goals so that we maintain acceptable gross margins while meeting the cost targets of our customers. We may not achieve adequate manufacturing cost efficiencies.

Because we plan to introduce new products and product enhancements, we must effectively transfer production information from our product development department to our manufacturing group and coordinate our efforts with our suppliers to rapidly achieve volume production. In our experience, our yields have been lower during the early stages of introducing new product to manufacturing. If we fail to effectively manage this process or if we experience delays, disruptions or quality control problems in our manufacturing operations, our shipments of products to our customers could be delayed.

Because the qualification and sales cycle associated with fiber optic components is lengthy and varied, it is difficult to predict the timing of a sale or whether a sale will be made, which may cause us to have excess manufacturing capacity or inventory and negatively impact our operating results.

In the communications industry, service providers and optical systems manufacturers often undertake extensive qualification processes prior to placing orders for large quantities of products such as ours, because these products must function as part of a larger system or network. This process may range from three to six months and sometimes longer. Once they decide to use a particular supplier’s product or component, these potential customers design the product into their system, which is known as a design-in win. Suppliers whose products or components are not designed in are unlikely to make sales to that customer until at least the adoption of a future redesigned system. Even then, many customers may be reluctant to incorporate entirely new products into their new systems, as this could involve significant additional redesign efforts. If we fail to achieve design-in wins in our potential customers’ qualification processes, we will lose the opportunity for significant sales to those customers for a lengthy period of time.

In addition, some of our customers require that our products be subjected to standards-based qualification testing, which can take up to nine months or more. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing and research and development expenses, expend significant management efforts, increase manufacturing capacity and order long lead-time supplies. Even after the evaluation process, it is possible a potential customer will not purchase our products. In addition, product purchases are frequently subject to unplanned processing and other delays, particularly with respect to larger customers for which our products represent a very small percentage of their overall purchase activity. Accordingly, our revenues and operating results may vary significantly and unexpectedly from quarter to quarter.

If our customers do not qualify our manufacturing lines for volume shipments, our optical networking components may be dropped from supply programs and our revenues may decline.

Customers generally will not purchase any of our products, other than limited numbers of evaluation units, before they qualify our products, approve our manufacturing process and approve our quality assurance system. Our existing manufacturing lines, as well as each new manufacturing line, must pass through various levels of approval with our customers. For example, customers may require that we be registered under international quality standards. Our products may also have to be qualified to specific customer requirements. This customer approval process determines whether the manufacturing line achieves the customers’ quality, performance and reliability standards. Delays in product qualification may cause aproduct to be dropped from a long-term supply program and result in significant lost revenue opportunity over the term of that program.

Our fiber optic components are deployed in large and complex communications networks and may contain defects that are not detected until after our products have been installed, which could damage our reputation and cause us to lose customers.

Our products are designed for deployment in large and complex optical networks. Because of the nature of these products, they can only be fully tested for reliability when deployed in networks for long periods of time. Our fiber optic products may contain undetected defects when first introduced or as new versions are released, and our customers may discover defects in our products only after they have been fully deployed and operated under peak stress conditions. In addition, our products are combined with products from other vendors. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to fix defects or other problems, we could experience, among other things:

loss of customers;
damage to our reputation;
failure to attract new customers or achieve market acceptance;
diversion of development and engineering resources; and
legal actions by our customers.

The occurrence of any one or more of the foregoing factors could negatively impact our revenues.

The market for fiber optic components is unpredictable, characterized by rapid technological changes, evolving industry standards, and significant changes in customer demand, which could result in decreased demand for our products, erosion of average selling prices, and could negatively impact our revenues.

The market for fiber optic components is characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. Because this market is new, it is difficult to predict its potential size or future growth rate. Widespread adoption of optical networks, especially in the metropolitan, last mile, enterprise access, and datacenter segments of the networks, is critical to our future success. Potential end-user customers who have invested substantial resources in their existing copper lines or other systems may be reluctant or slow to adopt a new approach, such as optical networks. Our success in generating revenues in this market will depend on:

the education of potential end-user customers and network service providers about the benefits of optical networks; and
the continued growth of the metropolitan, last mile, and enterprise access segments of the communications network.

If we fail to address changing market conditions, sales of our products may decline, which would adversely impact our revenues.

Disclosure requirements relating to “conflict minerals” could increase our costs and limit the supply of certain metals that may be used in our products and affect our reputation with customers and stockholders.

As required under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), the Securities and Exchange Commission promulgated final rules regarding annual disclosures by public companies of their use of certain minerals and metals, known as “conflict minerals,” which are mined from the Democratic Republic of the Congo (DRC), and adjoining countries, and their efforts to prevent the sourcing of such conflict minerals from these countries. These new rules will require us to engage in due diligence efforts beginning with the 2014 calendar year to ascertain and disclose the origin of some of the raw materials used in the production process. Initial disclosures will be required no later than May 31, 2015, with subsequent disclosures required no later than May 31 of each following year. We expect to incur costs associated with complying with these disclosure requirements, including due diligence to determine the sources of conflict minerals, if any, used in our products and other potential changes to our products, processes, or sources of supply as a consequence of such due diligence activities. The implementation of these rules and our compliance procedures could adversely affect the supply and pricing of materials used in our products. Not all suppliers offer “conflict free” conflict minerals, so we cannot be certain that we will be able to obtain sufficient quantities of conflict minerals from such suppliers or at competitive prices. Also, our reputation with our customers and stockholders could be damaged if we determine that certain of our products contain minerals not determined to be conflict free or if we are unable to sufficiently verify the origins of conflict minerals used in our products through the procedures we may implement. If we cannot determine that our products exclude conflict minerals sourced from the DRC or adjoining countries, some of our customers may discontinue, or materially reduce, purchases of our products, which could negatively affect our results of operations. In addition, our customers may require us to report to them on our conflict minerals compliance, and if we do not perform this function to a customer’s satisfaction, they may cease to do business with us.

We may be unable to successfully integrate acquired businesses or assets with our business, which may disrupt our business, divert management’s attention and slow our ability to expand the range of our proprietary technologies and products.

To expand the range of our proprietary technologies and products, we may acquire complementary businesses, technologies or products, if appropriate opportunities arise. We may be unable to identify other suitable acquisitions at reasonable prices or on reasonable terms, or consummate future acquisitions or other investments, any of which could slow our growth strategy. We may have difficulty integrating the acquired products, personnel or technologies of any company or acquisition that we may make. Similarly, we may not be able to attract or retain key management, technical or sales personnel of any other companies that we acquire or from which we acquire assets. These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses.

If we fail to protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our revenues or increase our costs.

The fiber optic component market is a highly competitive industry in which we, and most other participants, rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect proprietary rights. The competitive nature of our industry, rapidly changing technology, frequent new product introductions, changes in customer requirements and evolving industry standards heighten the importance of protecting proprietary technology rights. Since the United States Patent and Trademark Office keeps patent applications confidential until a patent is issued, our pending patent applications may attempt to protect proprietary technology claimed in a third party patent application. Our existing and future patents may not be sufficiently broad to protect our proprietary technologies as it is difficult to police the unauthorized use of our products and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where the laws may not protect our proprietary rights as fully as United States laws. Our competitors and suppliers may independently develop similar technology, duplicate our products, or design around any of our patents or other intellectual property. If we are unable to adequately protect our proprietary technology rights, others may be able to use our proprietary technology without having to compensate us, which could reduce our revenues and negatively impact our ability to compete effectively.

Litigation may be necessary to enforce our intellectual property rights or to determine the validity or scope of the proprietary rights of others. As a result of any such litigation, we could lose our proprietary rights and incur substantial unexpected operating costs. Any action we take to protect our intellectual property rights could be costly and could absorb significant management time and attention. In addition, failure to adequately protect our trademark rights could impair our brand identity and our ability to compete effectively.

We may be subject to intellectual property infringement claims that are costly to defend and could limit our ability to use some technologies in the future.

Our industry is very competitive and is characterized by frequent intellectual property litigation based on allegations of infringement of intellectual property rights. Numerous patents in our industry have already been issued, and as the market further develops and participants in our industry obtain additional intellectual property protection, litigation is likely to become more frequent. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies or rights that are important to our business. In addition, we have and we may continue to enter into agreements to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. Any litigation arising from claims asserting that our products infringe or may infringe the proprietary rights of third parties, whether the litigation is with or without merit, could be time-consuming, resulting in significant expenses and diverting the efforts of our technical and management personnel. We do not have insurance against our alleged or actual infringement of intellectual property of others. These claims could cause us to stop selling our products, which incorporate the challenged intellectual property, and could also result in product shipment delays or require us to redesign or modify our products or to enter into licensing agreements. These licensing agreements, if required, would increase our product costs and may not be available on terms acceptable to us, if at all.

Although we are not aware of any intellectual property lawsuits filed against us, we may be a party to litigation regarding intellectual property in the future. We may not prevail in any such actions, given their complex technical issues and inherent uncertainties. Insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. If there is a successful claim of infringement or we fail to develop non-infringing technology or license the proprietary rights on a timely basis, our business could be harmed.

Because our manufacturing operations are located in active earthquake fault zones in Taiwan, and our Taiwan location is susceptible to the effects of a typhoon, we face the risk that a natural disaster could limit our ability to supply products.

Our primary manufacturing operations are located in Tu-Cheng City, Taiwan, an active earthquake fault zone. This region has experienced large earthquakes in the past and may likely experience them in the future. In September 2001, a typhoon hit Taiwan causing businesses, including our manufacturing facility, and the financial markets to close for two days. A large earthquake or typhoon in Taiwan could disrupt our manufacturing operations for an extended period of time, which would limit our ability to supply our products to our customers in sufficient quantities on a timely basis, harming our customer relationships.

ITEM 5. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Stock Repurchase Program

On November 30, 2011, we announced a program to repurchase up to $6 million our outstanding common stock. Repurchases under the program may be made in open market and privately negotiated transactions in compliance with Securities and Exchange Commission Rule 10b-18, subject to market conditions, applicable legal requirement and other factors. We are not required to repurchase any amount of common stock in any period and the program may be modified or suspended at any time. We did not repurchase any shares of our common stock in the quarter ended September 30, 2013. As of September 30, 2013, approximately $0.02 million was remaining under this repurchase program. The duration of the repurchase program is open-ended.

ITEM 6: EXHIBITS

Exhibit Number		Title
31.1		Rule 13a-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a) Certification of Acting Chief Financial Officer
32.1*		Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
32.2*		Statement of Acting Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
101.INS**		XBRL Taxonomy Instance Document
101.SCH**		XBRL Taxonomy Schema Document
101.PRE**		XBRL Taxonomy Presentation Linkbase Document
101.LAB**		XBRL Taxonomy Label Linkbase Document
101.CAL**		XBRL Taxonomy Calculation Linkbase Document
101.DEF**		XBRL Taxonomy Definition Linkbase document

____________________

* In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the “Exchange Act”). Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 (the ”Securities Act”) or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

** In accordance with Rule 406T of Regulation S-T, the information furnished in these exhibits will not be deemed “filed” for purpose of Section 18 of the Exchange Act. Such exhibits will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: November 13, 2013

ALLIANCE FIBER OPTIC PRODUCTS, INC.


By	/s/ Anita K. Ho
Anita K. Ho
Acting Chief Financial Officer
(Principal Financial and Accounting Officer and Duly
Authorized Signatory)

Alliance Fiber Optic Products, Inc.
Exhibit Index

Exhibit
Number		Title
31.1		Rule 13a-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a) Certification of Acting Chief Financial Officer
32.1*		Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
32.2*		Statement of Acting Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
101.INS**		XBRL Taxonomy Instance Document
101.SCH**		XBRL Taxonomy Schema Document
101.PRE**		XBRL Taxonomy Presentation Linkbase Document
101.LAB**		XBRL Taxonomy Label Linkbase Document
101.CAL**		XBRL Taxonomy Calculation Linkbase Document
101.DEF**		XBRL Taxonomy Definition Linkbase document

____________________

* In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the “Exchange Act”). Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 (the “Securities Act”) or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

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Litigous
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Alliance Fiber Optic Products (AFOP) Inactive 10-Q2013 Q3 Quarterly report

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